Do Firms Purposefully Change Capital Structure? Evidence from an Investment-Opportunity Shock to Pharmaceutical Firms

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Author Information : Erasmo Giambona (Syracuse University)
Joseph Golec (University of Connecticut)
Florencio Lopez-de-Silanes (NBER and SKEMA Business School)

Year of Publication : Journal of Financial and Quantitative Analysis (2020)

Summary of Findings : High growth firms select a flexible capital structure to avoid debt overhang.

Research Questions : Do firms adjust their capital structure following an increase in growth opportunities?

What we know : A flexible capital structure is important to spur economic growth and entrepreneurial activities. These findings are important for entrepreneurs, corporate executives, and policymakers around the world concerned with the importance of finance for economic growth.

Novel Findings : Firms make their capital structure less constraining by decreasing leverage, shortening debt maturity, increasing unsecured debt, and reducing convertible debt. This study is the first to document these relationships in causal terms.

Full Citations : Giambona, Erasmo and Golec, Joseph and Lopez de Silanes, Florencio, Do Firms Purposefully Change Capital Structure?: Evidence from a Growth Shock to Pharmaceutical Firms (April 12, 2018). Available at SSRN: https://ssrn.com/abstract=2162376 or http://dx.doi.org/10.2139/ssrn.2162376

Abstract : We study the capital structure changes of drug firms after an investment-opportunity shock brought about by the Biologics Price Competition and Innovation Act. Using a difference-in-difference approach, we show that the shock led drug firms to make their capital structures less constraining by decreasing leverage, shortening debt maturity, increasing unsecured debt, and reducing convertible debt. New debt covenants became less restrictive and firms raised equity to preserve borrowing capacity. Our results support the view that firms actively manage their capital structures to bolster financial flexibility and increase debt capacity in response to new investment opportunities.

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Firms make their capital structure less constraining by decreasing leverage, shortening debt maturity, increasing unsecured debt, and reducing convertible debt. This study is the first to document these relationships in causal terms.

Erasmo Giambona
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